MR. DUNAWAY: Recent experience in the U.S. with high growth, low unemployment, and low inflation has led a number of observers to conclude that maybe there’s a new economy

Steven Dunaway

or a new economic paradigm in the United States. Other observers have been more skeptical, attributing this more to a series of transitional factors, including a surge in productivity, and that in time the old relationships between growth, employment, and inflation will begin to re-emerge.

A side part or an additional question in this is: Why has the United States benefited from these technological changes, whereas other advanced countries, particularly those in Europe, so far don’t seem to have displayed the same kind of productivity surge that we’ve seen in the United States?

The speakers we have here today hopefully will shed some light on these issues, and, at the conclusion of their remarks, you will be given an opportunity to raise any questions that may come up.

With us today are Dr. Thomas Duesterberg, who is the President of the Manufacturers Alliance, a policy research organization based here in Washington whose members are large manufacturing firms in the United States. Mr. Duesterberg is a former senior fellow with the Hudson Institute, and he served as U.S. Assistant Secretary of Commerce for International Economic Policy from 1989 to 1993.

Sitting next to me is Lawrence Mishel, who is Vice President of the Economic Policy Institute. Dr. Mishel has done considerable research in the area of productivity, competitiveness, income distribution, labor markets, and education. He’s co-author of the book “The State of Working America,” a comprehensive review and analysis of U.S. income, wages, and employment data, which is published biennially by the Economic Policy Institute.

And our final speaker today is Mark Wynne, who is a senior economist and research officer at the Federal Reserve Bank of Dallas. His research recently has focused on issues relating to economic integration in Europe; he also spent time at the European Monetary Institute working on issues related to the emergence of the single currency in Europe.

Today’s proceedings will follow the traditional framework for the economic forums. Each of the speakers will be invited to deliver brief remarks lasting roughly 15 to 20 minutes, and after all three have spoken, we will turn to the audience for any questions that you may have. In asking questions—and I’ll remind you of this when we get to the final segment where the questions are asked—we ask that you use the microphones by your seats by just simply punching the button. Also, please identify yourself and the organization that you represent before asking your question.

So we’ll begin with Thomas Duesterberg.

DR. DUESTERBERG: Thanks, Steve. It may seem a little churlish of me, a trade association official representing manufacturers, to talk about the new economy. I am going to take the position that there is something that we can call a new economic paradigm. But the news today was the National Association of Purchasing Managers found a considerable slowing in the manufacturing economy and General Motors announced a 10 percent cut in its salaried workers. So things are slowing down.

Nonetheless, what I want to talk about is focused on productivity. It’s become clear that information technology investment over the past ten years or longer has started to produce measurable results in terms of productivity growth. Total business sector productivity growth has averaged 2.7 percent over the past five years, far greater than the 1.7 percent of the previous 25 years. The equivalent numbers for manufacturing are even more striking, up from 3.0 to 4.6 percent, and durable goods manufacturing is up from 3.4 to over 6.2 percent in the last five years.

This has come late in an economic expansion and in the context of considerable increase in investment in information technology [IT] equipment. We believe that the coincidence of an unprecedented late-expansion acceleration in productivity growth and rapid investment in information technology is not accidental; rather, it reflects the profound and long-lasting positive effect information technologies and the business model they support have had on the production processes and management of both manufacturing and, we think, probably non-manufacturing firms as well.

I’m going to review some of the empirical evidence and then share some typical experiences of large U.S. manufacturers with regard to the productivity benefits of IT investment.

First, what is the new economic paradigm? Our conception of this may be stated as follows: Rapid innovation and investment in information technologies combined with globalization, deregulation, and a number of other competitive factors have spurred substantial and sustainable business process improvements and have permanently raised the rate of long-term, long-run productivity growth relative to the prior 25 years.

It’s important to realize that, although I will focus on the role of information technology, there are many other factors at work. Globalization has exposed U.S. firms to an unprecedented level of competition, forcing them to control production costs while simultaneously delivering more value to their customers.

A second important factor, we think, is deregulation, starting with airlines and trucking two decades ago, then moving to financial services, energy in the 1980s, and now unfolding in the telecommunication and electricity sectors. Deregulation in the United States has exposed many companies accustomed to operating under the protective cover of regulation to competitive pressures, forcing them to match the flexibility and innovation of their new competitors around the world. Deregulation and globalization have also spurred advances in management techniques ranging from quality control to supply-chain management to more efficient use of capital. All of these advances are abetted by better information technologies.

I also want to stress what we think the new economic paradigm is decidedly not. Most importantly, this paradigm by no means implies the end of business cycles. The causes of recession vary considerably and often cannot be controlled by policymakers or market adjustments. It would be irresponsible to assert that information technologies can counteract any or all external economic shocks. They may, as I will argue later, mitigate the magnitude of cyclical swings to a certain extent.

A second caveat for the new economic paradigm is that productivity growth rates are probably going to decelerate somewhat from their current rates. Productivity growth tends to be procyclical, and part of the phenomenal growth rate observed today is surely due to the fact that the U.S. economy is at or near a cyclical peak. However, long-run average productivity growth will remain well above the rates seen between 1970 and 1995 in both the manufacturing sector and in the economy as a whole.

Now I want to turn to the unusual productivity patterns that we have seen in the last five years. Despite a deceleration in the second half of this year, average productivity growth in both manufacturing and the economy as a whole has actually accelerated as the 1990s economic expansion has aged. Normally, productivity growth is strongest in the early years of a recovery as idle productive capacity comes back on line to meet demand. As the expansion matures, productivity growth generally slows due to decelerating growth in aggregate demand, an unwillingness to lay off employees immediately, and limits on the ability to invest in new productive capacity. In this way productivity grows above trend for several years before decelerating to a more sustainable trend.

The uncharacteristically strong resurgence of productivity at the end of a cycle may help explain a second unusual phenomenon in the current expansion: relatively low inflation pressure combined with extremely tight labor markets. Standard economic theory, at least in the past, predicted a short-run inverse relationship between the unemployment rate and core inflation. As the labor markets would tighten, employers generally would raise wages to attract employees. Based on the economic experience of the past quarter century, it was believed that unemployment rates under 5 percent would generally kindle inflationary pressures.

But even though the unemployment rate has been under 5 percent since July of 1997, core inflation, exclusive of the volatile food and energy components, has not exceeded 2.5 percent on a year-over-year basis. Clearly, the linear relationship between unemployment and inflation posited by the Phillips curve does not hold.

Let me now turn back to productivity growth in the last 25 years. There’s only one satisfactory explanation that reconciles the unusual economic situation: trend productivity has accelerated, driven primarily by manufacturing productivity. From 1970 to 1999, manufacturing productivity grew on average by 4.5 percent, a rate substantially higher than in previous periods. It also compares very favorably with the 2.6 percent average recorded during the golden age of economic growth, between 1950 and 1973.

Furthermore, examining the degree to which major components of GDP contributed to total growth over the three long expansions since 1960, I would point out that the investment component accounted for one-quarter of GDP growth in the current expansion—nearly double its contribution in the 1980s expansion, and well above that of the 1960s expansion.

Because investment is a vehicle by which new technologies are integrated into the production process, the 1990s saw an acceleration in innovation relative to prior expansions. I would also note that relative to both the 1960s and the 1980s expansions, government purchases have declined substantially. Government spending, of course, is driven by a host of considerations other than obtaining a return on investment and raising productivity, so it’s hardly surprising that the shift from government to private sector investment has been accompanied by increased productivity.

Investment in information technology has been the primary driver of the 1990s investment boom. Investment in information processing equipment and software has accounted for about 35 percent of total investment growth in the current expansion, which is more than any other major investment component. Measured in current dollar terms, investment in information processing equipment and software reached an annualized level of about $551 billion in the third quarter of 2000, 40 percent of total nonresidential fixed investment. Other durable goods investments by producers, including things like machine tools and transportation equipment, also grew strongly in the 1990s in relation to the 1980s.

After lagging behind in terms of performance some of the other G-7 countries, the relative gains from investment in the United States moved above trend between 1983 and 1999, and if you reviewed the periods a little differently and looked at, for instance, ’95 to ’99, you would see an even bigger change.

Now, let me turn to some empirical studies that have confirmed what the evidence in the preceding section strongly suggests. IT investment has had a substantial effect on the recent acceleration in productivity. Oliner and Sichel of the Federal Reserve Board analyzed the impact of IT capital on labor productivity growth. They used the standard growth accounting framework to decompose real GDP growth into its component parts. By factoring out GDP growth due to increases in hours worked, one can calculate the sources of productivity growth, and those results demonstrate that over 40 percent of the recent uptick in labor productivity growth is due to increases in the IT capital stock, with the large majority coming from computer hardware and software. The contribution of all other physical capital [things like machine tools] was slightly negative, although it still contributes a substantial amount to the overall productivity improvement in both periods. Improvements in the quality of the labor force contributed a negligible amount.

The largest contribution was from factors for which quantitative measurement was not feasible, a testament to the importance of intangible factors such as organizational structure, management practices, corporate culture, and other soft issues that can affect business performance in very big ways. Total factor productivity nearly tripled in the last three years relative to the 1974 to 1995 period and accounted for 57 percent of the associated acceleration in labor productivity growth.

The study notes that many of these factors are themselves related to the use of IT equipment in organizations, but doesn’t attempt to quantify them.

Contrary to skeptics of the new economic paradigm, the productivity acceleration of the last several years has begun to diffuse from the computer equipment manufacturing sector to other industries. Jorgenson and Stiroh clearly demonstrate this in their forthcoming study for Brookings. Using a growth accounting framework similar to Oliner and Sichel, they decompose growth in total factor productivity [TFP] into its sectoral components. They find that TFP growth increased substantially from 1995 to 1998 relative to the prior five years. In addition, they find that non-IT industries account for the majority of this acceleration. This acceleration provides evidence consistent with the spillovers from information technologies into non-IT industries. Even though they note that confirmation of this hypothesis is impossible using data available to them, our discussions with Manufacturers Alliance members across the spectrum provide a wealth of supporting anecdotal evidence.

There are other studies, such as Brynjolfsson and Hitt, that find robust evidence that IT investment, especially among firms with a decentralized management structure, increases productivity in the short term and enables productivity-enhancing process improvements over the longer term.

To close, I wanted to turn to some of the things happening on the front lines which we think might explain some of the increase in total factor productivity. I might add we had Bob Lawrence from the Council of Economic Advisors speak to one of our groups last week, and he reported that the next and final report of this current Council of Economic Advisers is going to focus on the new economy, and they are finding evidence that productivity increases above trend are branching out beyond the manufacturing sector into the service sector, so I’m looking forward to that report.

Empirical studies of aggregate data are essential for understanding the development of the new economic paradigm, but one must remember that those data reflect the sum total of millions of business decisions made every day in corporations across the country. I wanted to report a few of the things that we have found from talking with our members.

The most frequently cited benefits of IT investments among U.S. manufacturers stem from Web-enabled realtime information exchange between suppliers and customers, resulting in a coordinated and more flexible supply chain. Electronic marketplaces are getting most of the public attention, but the actual dollar savings are accruing behind the scenes.

The automotive industry provides a compelling example of the productivity benefits of such real-time information sharing. As a typical example, Toyota can electronically order one of 11 different frame models from the Dana Corporation, which can then produce and ship the desired frame in just nine hours. In addition to drastically reducing the time between order and delivery, this new information-sharing system gives Toyota increased flexibility in terms of their own production, allowing them to respond more rapidly to changes in demand, without holding inventory.

Such supply-chain compression benefits are common in other industries producing highly engineered products such as aircraft parts and components. In all of these industries, the recurring theme is huge boosts in terms of inventories. For example, since 1983, the inventory-to-sales ratio in all manufacturing has declined steadily. From 1968 to 1982, the ratio averaged 1.78. From 1983 to 1991, it was down to 1.66. Since 1992, the average has been 1.41, and it was 1.3 in 1999. This represents a huge increase in efficiency.

A couple of the other benefits IT investment: it’s revolutionized the efficiency and reliability of machining industrial parts. Boeing changed their manufacturing process for landing gear bulkheads to take advantage of the high-speed machining. Under the new process, bulkheads are made with two parts rather than 72, and require only 35 fasteners to hold them together rather than 1,720 under the previous method. Machining was completed 15 times faster.

Distributed information technologies permit a flatter organizational structure while maintaining accountability. Massive investment in enterprise resource planning systems have provided the infrastructure to implement a shared services model of corporate delivery. This allows companies to trim managerial overhead. The ratio of production workers to total workers, a rough measure of management density, increased from 61.5 percent to 66.9 percent in the last ten years in the auto sector, and from 66 percent to 68 percent in all durable goods manufacturing in the same time period.

I have some other examples, but let me just conclude by saying that we think the new economic paradigm is much more than e-tailing or business-to-business, or business-to-customer commerce. Much of it is hidden from public view in redesigned business processes, streamlined supply chains, flatter management structures, and other fundamental shifts in how goods and services are designed and produced. It has manifested itself in a secular acceleration of labor productivity in the last five years. It began in the computer equipment manufacturing industries, but now has spread throughout the manufacturing sector and is probably diffusing into nonmanufacturing industries as well.

We think that U.S. corporations are far from exploiting all the productive potential of information technology, partly because of the accelerating rate of innovation itself derived from the application of information technologies. So we anticipate further expansion of productivity growth into the future.

Thanks very much.

MR. DUNAWAY: Thank you, Tom.

Now, Larry Mishel.

DR. MISHEL: I’m here as the dissenter. That’s my role. I’m only going to partially dissent from some of the views that I think will be presented here. That is to say, I’m not going to dispute that the United States economic performance over the last four years has been better than what prevailed through most of the 1970s, ’80s, and early ’90s. I was a skeptic in 1998 when people said that we were in a new economy because we had two good years, 1996 and 1997, which followed three really bad years of ’93, ’94, ’95, and I didn’t think two years made a trend. But, you know, around five years makes you kind of think.

So I do believe that there is a higher rate of productivity growth. I think that the acceleration of productivity growth is due to, in large part, investment in information technology. My estimate would be around a third to a half of the acceleration is due to technology, IT-related developments.

Where I will surely have a different view is whether this improvement in U.S. economic performance is somehow unparalleled in our history or is driven by our basic laissez-faire deregulatory economic models due to the flexibility in the labor markets, meaning the flexibility to dramatically rearrange income and wealth distribution in favor of those who are best off and weaken the position of those at the bottom; whether those things are responsible for the improvements; and whether there is any reason to believe that Europe is a basket case that won’t benefit from this acceleration, or, in fact, is not doing better than the United States on many indicators; and whether, in fact, there’s any reason to argue that Europe should follow the U.S. model. I suspect it should not.

I can probably sit down now, but I’ll show you the data that I base that on.

I want to go over some indicators comparing U.S. and the advanced European economies. A lot of times the indicators that are used are just overall employment growth: millions of jobs or growth of GDP. And I’m going to skip right by those because those things are affected by how fast the working-age population is growing, and we should skip right to per capita income growth or something per worker or per hour, and not the rate of economic growth as a whole.

So, for instance, the first indicator I’m going to show you is per capita income growth. There are two conclusions I want you to draw from this. One is that in the 1980s you find that per capita income growth in the United States was middling. It was not better than anybody else, not worse than anybody else, but it was just sort of nothing to brag about. And in the 1990s you can see that Germany, Japan and Italy are all pretty close to the United States. There’s nothing other-worldly about the U.S. performance, but the U.S. did better than some other countries.

But let’s look at the next indicator, which is the growth of real annual compensation of the workforce.

You can see that in the 1980s the U.S. stands out as the only country where compensation per worker actually fell in real terms. In the 1990s, the United States does better than a few countries, but four of the other G-7 countries had better compensation growth per worker in real terms in the 1990s, and that’s in spite of the fact that in other countries annual hours of work have actually been shrinking when in the United States they’ve been growing.

So let’s look at what’s happened to Tom Duesterberg’s workforce. The hourly compensation of manufacturing production workers takes into account two other factors: it controls for hours worked, because it’s compensation per hour, and we’re looking at production workers, which are roughly 70 percent of the work force in manufacturing—the blue-collar service workers, not the managerial workers.

And you can see that, in this measure, compensation has actually been falling in the United States in both the ’90s and the 1980s, while it was growing overseas. This is a clear indication of something that’s not going well here, but is going well overseas.

This may shock you, but it shouldn’t because it’s based on data you can get from the Conference Board, from the IMF itself, or from the OECD. And if you don’t want to bleed for workers and the fact that their wages haven’t done so well in the United States relative to other countries, I want to show you a measure of the relative productivity of other countries to the United States, and its comparisons of output per hour worked. What you see is that, as of 1999, some advanced European northern tier economies—Belgium, Netherlands, France, and Germany have productivity levels equal to that of the United States. And you probably know that productivity growth in Europe over the last two or three decades has been around double that of the United States. That’s usually described as due to convergence, the fact that they are playing technology catch-up with the United States.

But the fact is that they have caught up, and if you look at studies for particular industries, there’s going to be a number of industries where Europe leads the United States, as well as some where we lead Europe. And if you look at other data, for instance, the OECD data would show Italy has also caught up to the United States. And I’m sure northern Italy is at or above the U.S. levels of output per hour.

So I want to make a very strong challenge to those who say that the U.S. model is just the first and only model to follow, and that Europe is burdened by a big welfare state, labor protection, strong unions, strong social insurance, and everything that is not laissez-faire. Well, if they’ve been doing everything wrong for two decades, then how did they manage to catch up in terms of the fundamental measure of efficiency in the economy? I suspect that it can’t be all that bad. I’m not saying that we have to follow their path, but it’s also not so true that we should write them off as some inferior types of economies.

Looking at investment as a share of GDP in nominal terms, I just want to show that, for the 1990s on average, the United States has not basically invested a larger share of its GDP than other countries. In fact, for most of the last few decades, we actually have a lower investment share in the United States, and that is usually blamed on the fact that we have a savings problem, et cetera.

I want to directly raise the questions of the position of low-income, low-wage workers and the problems of inequality, and examine the purchasing power of the wages of a low-wage worker in different countries. In Germany in 1991 a low-wage worker would earn around twice as much as in the United States; Europe on average, around 40 percent more; even the U.K., which is the low-wage country among the G-7, low-wage workers would earn more than the United States, as well as in Japan.

The United States has by far the largest inequality in the post-war period and a far larger amount of wage inequality and income inequality than other advanced countries. And if you believe the other prior data on productivity, it doesn’t seem to me that this growth of inequality was somehow necessary to achieve a certain level of efficiency.

I’ll grant anybody that the U.S. has a better record on unemployment than many other countries. Yet there are seven European countries that have unemployment below 5 percent, so I’m not so sure that their systems necessarily mean you have to have high unemployment. But that is one measure where generally the U.S. would do better than other countries. I think that’s well known and I won’t go over that.

Let me just make a couple of comments about the recent U.S. recovery. Things did get better in ’96, ’97, ’98, ’99, and 2000. Economists were not very good at understanding the productivity slowdown, and I don’t think we’re really going to get very good at understanding the productivity acceleration.

Business Week has been writing about the new economy since 1992. There’s no reason to believe that somehow technology all of a sudden hit in 1996. There’s room for skepticism about that. But one thing I think is pretty sure is that the U.S. recovery and the good performance in the last five years is not due to anything having to do with labor market flexibility; let me give you some indicators of that.

One is that the wage gap at the bottom between the low-wage worker and the middle-wage worker has actually been declining. We’re not seeing an increase of wage flexibility that’s leading to greater inequality as a way to generate growth. That’s actually been in decline in the last four or five years.

We see a decline in the share of people that are self-employed in the United States. And the United States, by the way, doesn’t have a greater share of self-employment than other countries, even though that’s often used to say that we’re very dynamic.

Retail trade is a sector in which it is sometimes argued that other countries don’t have a good employment record because they don’t have enough of a low-wage service sector, particularly retail trade. Well, it turns out in the United States the retail trade sector as a share of employment has fallen in the 1990s, particularly in the last four or five years. So our peak performance has nothing to do with expanded retail trade, although retail trade productivity has grown a lot.

We also see a shrinkage in the share of workers working part-time, both those who work part-time that want full-time work but also those working part-time that claim that that’s what they want. And I suspect that much of the growth of part-time work over the last 20 years, even among those who said they wanted part-time work, was really because that was what was available to them.

So I just want to mention that the indicators of so-called labor market flexibility have been moving to less flexibility in some ways rather than more flexibility in this kind of recovery.

Let me close by just giving some caveats about the role of technology in the recent boom.

The major reason that you can attribute to IT a role in the acceleration of productivity is because there’s been an increase in investment of capital equipment, IT-related equipment, and software. And I think that’s very real.

I guess I agree with Tom that we may not see that continue as great as it is now, but it will continue. So if you want to talk about speed limits for the U.S. economy, I think we should raise it. It may not be as high as it is right now, but I’m seeing it’s going to be a lot higher than what it was in the ’80s and early ’90s.

But it also remains to be seen whether this capital surge is some kind of over-investment in IT.

You can track the role of information technology on overall growth, as done by Oliner and Sichel and other people, but we should also recognize that IT equipment substitutes for other types of capital, and so the net effect is really how much IT equipment you put in less what you would have put in in non-IT equipment.

I think there’s also a caveat about the degree to which IT is improving the productivity of the users. If you look in the OECD Economic Outlook last June, you will see that the U.S. is not doing better or even as well as many of the other G-7 countries or some of the smaller European economies in terms of multi-factor productivity growth, which would capture the use of IT equipment. So I’m not so sure that things have really spread.

No one really tracks whether the actual industries that are improving a lot in their productivity are the ones that actually use a lot of IT equipment. I don’t think there’s necessarily that association in the service sector, even though service sector productivity has grown.

And one reason it’s grown is just what I call persistent low unemployment. We haven’t had a period like this, in some ways because of the higher productivity, but we also haven’t had a period like this where there’s been a persistent labor shortage—unemployment below 5.5 percent for five years. And it seems to me that the service sector in particular, which is the one that tends to use a lot of the least-educated, disadvantaged workers, is a sector where they haven’t been able to add employment as easily as they used to, but they still try to satisfy demand. This is an old Keynesian argument, right? Businesses don’t turn away customers. They find some way to get the goods and services out the door, and they’ve been finding lots of different ways of doing that for the last three or four years because they haven’t been able to add workers as quickly.

A last point: giant measurement questions. These are nerdy economic questions about comparing what happened in the United States versus the past, but also us versus Europe. Most of the differences that you can show in lots of charts between the U.S. and Europe make the U.S. look a lot better because we measure what happened to computer prices in the IT sector differently than Europe does. And if you do things on an apples-and-apples basis, you would find the comparisons would not tilt in favor of the U.S. In fact, I think most of the comparisons don’t necessarily tilt in favor of the United States. So it would look less likely that we have the IT new economy, or that everybody has to reduce government and get rid of their unions and labor protections in order to share it.

Thank you.

MR. DUNAWAY: Thank you very much, Larry.

Mark?

DR. WYNNE: Thank you. I’ve been asked to address this question of whether Europe has a new paradigm or new economy, and if not, why not?

Interestingly enough, my boss, the President of the Federal Reserve Bank of Dallas, Bob McTeer, posed the exact same question about a year ago.

As some of you may know, within the Federal Reserve System, the President of the Dallas Fed is probably known as the most outspoken advocate of the new economy view. And it seemed puzzling to him, and I think to many other people when you think about it, why the new economy that seemed to be so prevalent in the United States also seemed to be passing Europe by, especially given the preponderance of highly skilled labor and world-leading firms in many categories within Europe. So I’m going to look at why Europe seems to have lagged so far, and also suggest some reasons for why it may change in the not too distant future.

A lot of what I’m going to have to say may strike you as being familiar to the point of being a cliche, but there are important changes under way in Europe driven primarily by the process of European integration, that are fundamentally altering the landscape and business environment on the continent.

I just want to make three main points here. First, I want to talk briefly about how different the performance of the United States and Europe has been over the past five years; and some of the differences are quite striking. And then I want to advance some reasons for why Europe has not really been at the cutting edge of the new economy, the new paradigm.

I think the essence of the argument or the reason is the oft-cited problem of overregulation and overgovernment in Europe. I know a lot of people have heard this, and it’s challenged, at least implicitly, by the previous speaker’s comments, but I think this is an important component of the story. It’s stifled or has held back entrepreneurship that has been a key part of the emergence of the new economy in the United States, and it has been a drag on innovation in the past.

I do, however, think that it’s changing, and it’s been changing for the better, and is being driven by the process of European integration in part.

Now, by the new paradigm—I guess there are as many definitions of new economy or new paradigm as there are people who speak about it—I just mean the combination of high growth, low inflation, low unemployment, driven by rapid productivity growth, primarily in the IT sectors, that the U.S. has experienced over the past five years.

If we looked at some statistics on the comparative growth performance and productivity growth performance of the U.S. and EU over the past decade, we’d see that for the first five years, from about 1990 through 1995, there weren’t really very dramatic differences in the performance of Europe or the U.S. in terms of productivity growth. All of the difference has emerged since 1995. And that acceleration in productivity growth is what lies at the heart of the new economy or new paradigm in the United States, and that in turn has made possible the rapid rates of growth that we have experienced over the past five years, the low and declining inflation over the past five years, and the low unemployment and tight labor markets that we’ve also experienced.

People have noticed, and European investors have noticed, that if you looked at statistics on the net purchases of U.S. equities by Europeans over the past 15 to 20 years, you see that until the mid-1990s, they netted out to be about zero. But since 1995 or 1996, there has been a flood of European investment into the United States, largely to take advantage of the superior investment returns offered by the new economy here, and this partly explains the recent weakness of the euro over the past two years and the flow of capital out of the EU into the U.S.

Now, before turning to considering the foundations of the new economy or the new paradigm, it’s worth pausing to ask what exactly happened in 1995 or 1996 to give rise to this sudden change in the U.S.’s circumstances. And I think most students of U.S. productivity performance point to three key developments in those years.

The first was a noticeable acceleration in the rate of decline of computer prices. Computer prices, properly measured, have been going down at a rate of about 15 percent a year from the mid-1980s through the mid-1990s. Then in the mid-1990s, the pace of decline accelerated to about 30 percent a year.

Now, the exact reason for this is not entirely clear, but a lot of people point to a decision on the part of Intel to rapidly increase the rate at which it got products from development to market, so that Moore’s law, which previously stated that the capacity of semiconductors doubled every 18 to 24 months, really needed to be reformulated to read that the capacity of semiconductors being sold doubled approximately every 12 months.

A second key development in 1995 and 1996 was the beginning of extensive use of the Internet for commercial purposes. This was the first time that companies like Dell, Cisco, and Amazon all began to do business online.

And the third factor, often overlooked, was the effective completion of deregulation of the U.S. telecoms industry which ended the local loop monopoly. This is important because if you look at statistics on the number of Internet hosts per capita around the world, it’s pretty much related to how costly it is to go online. It’s pretty cheap to go online in the United States, and the United States has more Internet hosts per capita than any other country in the world. It’s costly to go online in most other countries, especially in Europe, with the exception of the Nordic countries, so you don’t see as much Internet use.

Now, the factors that underlie the emergence of the new economy in the United States and its slow development in Europe primarily have to do with the role of government in the economy, I think. I think the burden of government, competitive environment, entrepreneurial environment, access to capital, and the use of technology are all key elements in explaining the different performance of the U.S. and the EU over the past decade.

I don’t think I need to go through the statistics on how heavy the burden of government is in Europe. Crudely put, European governments spend about half of European GDP, whereas the comparable U.S. figure is about 30 percent. These high levels of expenditure in turn necessitate high levels of taxes. Tax rates on labor in the United States run at around 20 percent, appropriately measured, whereas the comparable tax rate on labor in France is closer to 50 percent. Consumption is taxed a lot more heavily in Europe as well.

Along with the heavy burden of government, businesses in Europe operate in a far less competitive environment than their American counterparts. Historically, this lack of competition was due to heavy government intervention or regulation of businesses, and in terms of relationships between European countries and with the outside world, to tariff and nontariff barriers to trade for a long period of time, and to the extensive state ownership or state aid to companies when they get into trouble.

Almost all the internal barriers have been eliminated because of the Common Market, but European businesses still operate behind a higher common external tariff, of about 7 percent or so, than do their U.S. counterparts. So they don’t feel the cold winds of competition as intensively as the firms here do.

I think a third key element in the story is the differences in the levels of entrepreneurship and social and cultural attitudes to entrepreneurs. Differences in levels of entrepreneurship reflect a variety of other more fundamental factors, regulatory obstacles being the most obvious. It’s a lot easier to register a company and file a patent in the United States than is the case in Europe.

Bankruptcy legislation in Europe errs excessively on the side of protecting creditors and penalizing business failure than is the case here. Entrepreneurship is hindered by difficulties in raising capital and barriers to the provision of stock options to senior management. In fact, in Germany and Finland, until about two or three years ago, it was illegal to compensate employees by awarding stock options. Just looking at how important this form of compensation has been in the United States in recent years, and especially in the high-tech sector, gives you some sense of how important it may be as a factor explaining the differences between the United States and Europe.

The structure of financial markets, the heavier reliance on banks in Europe instead of capital markets, is also often cited as an obstacle to innovation and the development of new businesses. Limited access to venture capital, and excessive government deficits absorbing such capital as was available until rather very recently, are all big differences between the United States and Europe over the past decade.

Now, we could look at things like the rate of utilization of the new technologies. Approximately 95 percent, or essentially all, U.S. white-collar workers use a personal computer on the job. Only about half of European workers use a PC on the job. Another way of looking at this is there’s about one PC for every two people in the United States. The comparable figure for Europe is only about half that or maybe slightly lower.

I mentioned the greater number of Internet hosts per capita here. Again, it’s off the scale when you look at the U.S. compared to the rest of the world. That in large part reflects, you know, the law of demand. It’s a lot less costly to go online here than is the case almost anywhere else in the world.

Now, is the new paradigm or new economy going to pass Europe by? I don’t think so. I think that the changes that have been going on in Europe over the past 40 years—this movement towards a more integrated single market—are going to create a much more business-friendly environment in the near-term or medium-term future. The two most important developments in this regard over the past 15 years have, of course, been the Single Market Act, which aimed at eliminating all remaining barriers to trade between the members of the European Union; and the launch of European economic and monetary union last year, which has seen the creation of a single currency for about 300 million people starting next January. I think these are two important developments that are going to change the business landscape and make it a lot more business-friendly in years to come.

In terms of real changes wrought by monetary union, the most important has been to deepen and strengthen the single market and to facilitate the development of pan-European capital markets. I think even the most wild-eyed euro optimists have been surprised at the pace with which Europe-wide capital markets developed in the past two years following the launch of monetary union, and the emergence of those capital markets has greatly facilitated a lot of merger and acquisition activity and industrial consolidation that otherwise might have been further delayed.

Other provisions in the treaties governing monetary union limit the ability of national governments to provide aid to failing firms. Now, just how binding a constraint this is is not immediately clear, but it does sort of dampen the worst impulses of some governments to immediately throw taxpayer money at large industrial conglomerates when they get into trouble rather than allow the natural process of restructuring to go on.

I think many of these developments have begun to bear fruit. The one area in which Europe clearly leads in terms of the new economy or high technology is mobile telephony. And, clearly, the existence of a single standard for wireless communications in Europe has greatly facilitated the adoption of mobile phones there. While Internet penetration rates and Internet usage rates are much higher in the United States and mobile telephony is less common, you see the reverse pattern within Europe.

Europe is also leading the way in the development of a lot of the applications for third-generation telephones, things like m-commerce, and there seem to be a lot of emerging centers of Internet activity in Europe, far more than was the case for the traditional PC industry.

Now, I could go on and on, but I think the bottom line is that the process of integration, the single market, the more market-friendly policies of governments, deregulation, and privatization are creating a much more favorable business environment that over time will facilitate and create a better environment within which big technological innovations can be adopted and brought to business use in Europe and potentially lead to new-economy-type developments.

I think we’ve seen something of it. Instead of considering Europe as a whole, look at some of the individual countries for evidence of how market-friendly policies can help things. One case in point is what’s happened in Ireland over the past decade, where you had a shift away from very traditional statist policies of heavy public sector involvement towards low taxation of business income and a more business-friendly environment, more deregulation. And the payoff was rates of GDP growth in the 7 to 10 percent range in real terms for most of the past ten years.

Now, I don’t think the move to market-friendly policies explains all of what’s happened in Ireland. It had a long way to go in terms of catching up. It benefited from structural funds from Europe and a variety of other one-off factors. But if you look at these attempts to measure economic freedom around the world, Ireland is one of those cases where it just shot up in the rankings in the past ten years and that greater economic liberalization has been reflected in better economic performance.

So, to conclude, I think there is something to the new economy story in the United States. I think some of the most outspoken proponents may oversell the case a bit, but fundamentally it reflects the great strengths of the U.S. economy in terms of the dynamic business environment, the entrepreneur-friendly culture, the relatively low obstacles to business formation, and a reallocation of resources from declining sectors to rapidly growing sectors.

I think the process of European integration is going to create a similar, albeit not identical, environment within Europe in the not too distant future, and I would expect that to be reflected in some new-economy-type developments there over time.

Thank you.

MR. DUNAWAY: Well, at least to me, this has been a very interesting exchange of views. And I think we’ve done a good job of showing where there’s some commonality in viewpoint and where some of the differences lie.

Now I’d like to throw it open to you in the audience, if you have comments or questions. As I said before, if you would use the microphones in the arms of the chair next to you, just press the button and please identify yourself and the organization you’re with.

QUESTIONER: I have a comment about Lawrence Mishel’s presentation. I’m actually quite surprised that in your presentation you basically treated the unemployment performance of the U.S. almost as an aside to the discussion on the labor market indicators. One could think that the low rates of unemployment in the U.S. are the counterpart of the increase in income inequality and of comparable rates of productivity. The U.S. has all these lower-skilled workers that are employed, so, of course, it’s going to dampen labor productivity levels.

Now, when you look at Europe, you see countries that have declining rates of unemployment, like France, have also been facing a strong deceleration in labor productivity. And one could explain that by the reintegration of lower-skilled workers into the labor force. And so I would guess that in a couple of years from now, one would have the level of productivity growth in France being lower than in the U.S. if the trends continue.

Also, saying that the U.S. labor market is not more flexible because part-time employment and self-employment’s share has been declining seems exactly the opposite of the point. We know that the share of self-employment in the economy is a countercyclical measure. So when the economy booms, the ratio of self-employment should decline. That doesn’t mean that the labor market’s not flexible. It just means that these people have been integrated in independent employment in other parts of the economy. That’s certainly true in developing economies, for instance, and the same thing with part-time. A lot of the part-time workers are part-time workers not because they chose, but because they didn’t have the opportunities. With an expansion, the share of part-time would decline.

So it just seems to me that you painted a picture that is more bleak for the U.S. than, in fact, it is. Maybe one exception would be the Netherlands, which has been having very strong growth of output and has a rate of unemployment of 3 percent and good productivity growth. But besides Netherlands, I can’t think of any other country that has the productivity growth and unemployment performance that the U.S. does.

DR. MISHEL: Well, I didn’t dwell on the unemployment because I know everybody knows about that. I think there’s every reason to really revel in the low unemployment the United States has had for four or five years. I think it’s really very important, and it’s been very important to all segments of the population. So I don’t undervalue it at all.

In the recent book we wrote, one of the main themes was, in fact, to try to identify the benefits of the persistent low unemployment, and some of the low unemployment is due to the higher productivity and some of it is not. And some of the benefits we see are from higher productivity and some of the benefits in the labor market we see are from low unemployment.

In terms of whether higher unemployment in Europe can explain why they’ve been able to catch up in productivity levels, I suspect that that’s not the case. Actually, the easiest example is Germany.

Germany, if you look at the recent Groeningen Conference Board numbers, has productivity levels that are around 10 percent greater than the United States. The unemployment rate in Germany might be 2 or 2.5 percent more than that of the United States.

If you just took 2.5 percent of Germans and added them to the economy at zero output, you’d still have productivity levels in Germany far in excess of that of the United States. Instead of 110 percent above the U.S. levels, maybe it’s 107 percent above the U.S. levels.

And it’s also not true that the composition of unemployment in Europe is very disproportionately weighted towards the low-end workers. There are lots of college graduates. I mean, the mix is not what it is often made out to be.

If you just looked at output per worker and corrected for hours, you’d see differences. If you want to just add more workers at zero output, you’d see the same thing. The fact is they’ve caught up substantially.

Now, I don’t believe the measurement of these numbers is such that I would bet on anything above plus and minus five percentage points. There’s a bunch of advanced countries where, no matter how you measure it, no matter whether they have unemployment rates like ours, they would have efficiency like ours. And I don’t see that really taken into account in most of the analyses.

MR. DUNAWAY: Another question?

QUESTIONER: My question is directed to Dr. Duesterberg. You have been looking at European countries in terms of their investment-to-GDP performance. I wonder if you think it would look different if you were plotting just information technology investment against GDP.

DR. DUESTERBERG: Yes, I think it probably would look a lot different. I don’t have those numbers on the tip of my tongue.

It would seem, partly in response to your question and partly going back to the previous question, that another interesting question is the capital intensity ratio for workers. It appears that part of what was happening in Europe in the last couple of decades was increasing capital intensity as labor conditions—as employment or unemployment—rose, and that may have something to do with the fairly robust productivity numbers, especially in the 1980s and early 1990s.

There have been anecdotal reports and some early statistical evidence that that situation in Europe may be reversing a bit, as I think the previous questioner was suggesting. As unemployment is starting to come down, the capital ratio is starting to come down as well. So it may be interesting to watch the results of that in comparative terms over the next few years.

QUESTIONER: May I follow up? The implication of my question was: Is this a question of catch-up? Maybe the Europeans are not as much into the investment in information technology. I got a very different impression, I thought, when I was listening to Dr. Mishel.

DR. DUESTERBERG: Well, I think it is a question of catch-up in Europe. Again, I don’t have those numbers at the tip of my tongue, but the investments on this side of the Atlantic in information technology in the last 10 to 15 years have been absolutely stupendous. And while I don’t have the comparative numbers for Europe, they’re quite substantially less.

DR. MISHEL: I think there’s no doubt that they’re behind in some of this IT investment, and I guess there’s no reason to believe that they won’t catch up. I think there are certain countries in Europe that have high Internet and telephony usage. And I just want to point out that they have the same large tax rates and burdensome government as the other parts of Europe that are behind. So I’m not so sure that that is exactly what’s preventing the catch-up in the IT world.

QUESTIONER: Concerning some of the comments that Dr. Wynne made regarding what’s happening with European economic policy, namely, deregulation of various industries, privatization: certainly in Great Britain and Germany there’s emphasis on lowering marginal tax rates. When you look at the panoply of policy changes that are occurring in Europe, it really calls into question, I think, the notion of the European model. It’s certainly changed, and it is changing dramatically over time, and it is emulating U.S. policies rather than vice versa. And given that you think that the economic performance in Europe is so superlative relative to the U.S., it calls into question why they would be doing that.

DR. MISHEL: I’m not arguing that the European model is superior to the U.S. model. I just think there’s a lot of very simplistic, cursory argumentation that goes that the U.S. is so great and Europe is so lousy and that Europe has to be like the United States.

Those countries that are maybe moving towards flexibility and doing things like you’re saying or that Mark suggested, I’d give my right arm for the social protections and labor protections that they still have, which are far better than we have in the United States. There’s no one in the Netherlands that lacks for health insurance or that’s not going to have a good pension.

The proportion of people who work part-time has increased a lot. There are laws that say that people who work part-time have to be paid at the same hourly rate as people who work full-time. That’s something we don’t even think about in this country.

So there may be ways that they need to adjust their economies, and it doesn’t necessarily suggest that they need to be like us. It could be that there are lots of ways we can move to be like them and still be better off.

DR. WYNNE: I guess the only observation I would make is that it’s highly unlikely that Europe would ever move all the way towards fully adopting the American model for a variety of reasons, and it’s not clear that that would be desirable, anyway. I think that traditionally they’ve overdone the social side of things and paid little attention to the market side of things, and in the past decade they’ve been shifting the relative emphases, realizing that some of the interventions and regulations have been extremely costly and have ended up being more of a burden than is truly justified by the supposed benefits.

I wouldn’t disagree an awful lot with what Lawrence Mishel said about the high standards of living in Europe, having lived there a long time. There are a lot of very simplistic statements made about the relative standards of living between the United States and Europe. Europeans are much wealthier: I think they have a higher standard of living than might be indicated by a simple crude comparison of per capita GDP levels. All the social benefits do have real payoff to the citizens. They’re not imposed. These are things people vote for.

But I also think some of the statistics that Lawrence had on relative productivity levels are highly questionable. Having lived in Germany for a year and a half, I have very personal experience of just how inefficient and unproductive the German service sector is.

Now, we know that German manufacturing is world-beating and their productivity levels are way ahead of what we see in the United States, and I think there it’s very easy to measure and make these comparisons. But you look at German banking and German retailing; go to a restaurant in Germany, and then compare your experiences with what happened here, it would make you question whether at least service sector workers in Germany and many other parts of continental Europe are as productive as their counterparts here.

DR. MISHEL: Well, it may be that the data are wrong, but then we just should not use GDP data for Germany. We either believe the GDP per hour work numbers as the IMF and the OECD and Groeningen and the Conference Board do, or we don’t. So I grant you the service sector in Germany is just not the same thing.

QUESTIONER: Could I ask what those GDP figures and productivity figures represented? Was that economy-wide or was that just manufacturing?

DR. MISHEL: The numbers are economy-wide, and there are other numbers you can get that may deal with specific manufacturing, and those would show that some manufacturing is more productive in the United States and some less, which should not be surprising.

MR. DUNAWAY: Any other questions? Yes, please?

QUESTIONER: Are there any signs of the new economy emerging in Japan? If not, can you give us some comment of why there is no sign?

DR. DUESTERBERG: I’ll take a stab. The Japanese economy has always been a two-tier economy. There has been a global sector that has been extremely productive, rapidly growing, and rapidly innovating, and there has been a much larger sector that is largely protected from international competition and which is much less productive. Studies that McKinsey did in the last ten years or so on sectoral comparisons of productivity I think amply bore that out.

Following up on Mark’s definition of what constitutes the new economy, I think there is both an institutional and a cultural aversion to change that is much stronger in Japan than it is, for instance, in the United States, and that that inhibits the ability to adapt rapidly, to innovate rapidly, and to allow the sort of creative destruction which is one of the hallmarks, for better or for worse, of the new economy.

So I see relatively few signs that Japan is adopting that model and instead that there is a considerable amount of resistance to that. In fact, layered in on top of that, I think one has to start focusing on investment in Japan in recent years. The massive public sector investment that has been used in the last ten years to stimulate the economy has not been the most productive in terms of advancing anything approaching a new economic paradigm. And I think you see in the data about investment that the return on investment in Japan has been much lower than either the United States or Europe, and I think that probably has something to do with the allocation of investment to public sector projects like infrastructure, which are less productive. So I think that bodes ill for the adoption of anything approaching a new economic paradigm.

DR. WYNNE: The only thing I would add is that there have been some well-publicized examples of where Japan has been on the cutting edge of some of these new technologies. Again, in the mobile telephony area they seem to be up there with the leaders. But I think there’s a lot more to the new economy than being able to read the Wall Street Journal on your telephone.

What it really has to do with is changing business models and changing business practices, a more dynamic business environment, and a lot of the factors that Thomas was mentioning in his speech on how product innovation goes on. I’ve never seen much evidence in Japan of any fundamental changes along those lines similar to what we’ve seen in the United States.

MR. DUNAWAY: One last question and then we have to wind up.

QUESTIONER: We must consider that Europe has got for the first time four things which United States had for centuries: number one is the euro, the single currency; number two is the euro norm, the unified standard; number three is one language, English is now mostly accepted; and number four is one market.

The race between U.S. and Europe has only started now on level ground. So if we had to observe economic performance, it has to start now when they have got equal denominations.

I want to know the views of the speakers on this.

DR. WYNNE: Well, the thrust of my presentation was in that direction. I think Europe is much closer to enjoying many of the home-field advantages, if you will, that the U.S. has enjoyed for a long time: the very large single market on which to test products before going overseas, single standards, integrated capital markets, money markets and so on. So I would be very, very leery of projecting from past performance what the next decade would hold.

I do, however, think that the built-in rigidities in Europe will be something of an obstacle. Though a lot of them are being dismantled or eroded, there is still a very important, fundamental difference that may engender a permanent gap between Europe and the U.S. for quite some time to come.

MR. DUNAWAY: Well, I want to thank the speakers today for their participation and also to thank you for coming. A full transcript of today’s discussion will be available on the IMF’s website within a few days.